2007 Second Quarter Call, THURSDAY, JULY 26, 2007

SECOND QUARTER 2007 CONFERENCE CALL

Joseph Cross, President and CEO

Welcome to Nanophase’s conference call to review the record second quarter and record first half of 2007 results. The Company experienced exceptionally strong revenue growth in the second quarter and first half; it is an excellent way to continue fiscal 2007. The second quarter marks the 10th consecutive quarter of record year-over-year revenue growth.

To begin our discussion, Jess will summarize the financial highlights of the quarter and first half. Jess...

Jess Jankowski, CFO

Good afternoon and thank you for your continuing support of Nanophase.

The second quarter results highlight the achievement of three exciting milestones. First, we achieved another quarterly revenue record with $4.1M in Q2 revenue, a 73% improvement over Q2 of last year. The second milestone is really more of an internal metric. We achieved positive EBITDA of $60,000 and, when adjusted for equity compensation expense and imputed revenue, we achieved EBITDA-O, for wont of a better term, of $138,000. This is an important milestone marking progress towards our goal of GAAP profitability. Lastly, we concluded an equity financing which closed on June 29th and was funded in the amount of $10.6 million at the beginning of Q3. More to follow on that later…

Reviewing the financial performance, I intend to only address significant areas comparing Q2 of ’07 to Q2 of ‘06. I will also discuss some of the half-year 2007 to half-year 2006 comparisons, but I feel that Q2 of ’07 is more representative of the Company’s current performance path. As always, all numbers for this call will be in approximate terms for ease of discussion. For more details, please see the financials accompanying today’s press release. We have added a supplementary schedule, along with the press release, to break out depreciation and equity compensation expense, both of which are non-cash items, in order not to bog down the call with detailed verbalized information. I will also continue to discuss a few new metrics that highlight some important positive shifts in our business.

The growth from our architectural coatings customer, and from the expanding relationship with BYK Chemie, showed increased revenue when compared with last year’s second quarter, of $1.2million and $500K, respectively. These represent the main differentiators between this past quarter and Q2 of 2006.

In terms of revenue mix, Nanophase used to have one major customer, BASF, which had been responsible for the great majority of our sales over the preceding five years. In 2006, sales to BASF accounted for 56% of total revenue, while continuing to grow in dollar volume. BASF’s historical average had been 69% from 2001 to 2005. In keeping with this trend toward greater diversification, for this past quarter, revenue from BASF amounted to 36% of total revenue, and was surpassed by our architectural coatings customer which accounted for 41% of Q2 sales! Revenue from BYK Chemie, our largest industrial coatings customer, accounted for an additional 14% of sales this quarter. As you can see, our revenue is getting better-distributed between several large customers which makes us less dependent upon any single customer.

For the recent six months ended, BASF, our architectural coatings customer and BYK Chemie accounted for 44%, 32% and 14% of total revenue, respectively. Although these three entities often represent the faces we ship to, there are certainly more than three companies that are driving 90+% of our current revenue. Particularly with BASF and BYK Chemie, many underlying customers of our two partners create demand for Nanophase’s materials. BASF has multiple customers driving their demand for our materials, each having gone through product qualification cycles, some extending beyond a year. BYK Chemie is selling our materials to an even larger number of downstream manufacturers and processors. This is also true of Rohm & Haas’ CMP business, which sells to a broad group of polishing customers, each of whom has rigorous qualification standards.

I reiterate this because many people initially assume that Nanophase’s concentration of sales to several customers represents a liability. With BASF and BYK Chemie, we have effectively increased the breadth and reach of our market attack. We are now selling materials for use on almost every continent. This broad distribution, both among end-user manufacturers and geographically, is a stabilizing force for Nanophase that will only strengthen over time. Our business model is now delivering.

Gross margins for Q207 amounted to 37% of revenue, versus 23% for Q206. In dollars, we had almost a million more in gross margin, or gross profit, on additional revenue of $1.7M. Looking closer, that shows we had an incremental gross margin in excess of 56% on the added volume. While we like the margin growth we’ve seen, some of it has been offset by increases in commodity metal prices, that we have largely recovered, albeit not at the percentage margins of the pre-increase sales, and in overtime worked to react to demand that has been difficult to predict. We also added direct labor and hourly manufacturing support staff in Q1 to support our revenue ramp.

As the product mix matures and stabilizes, we expect margins to grow. Still, predicting a precise trend will be difficult for the balance of the year.

Moving down,

R&D Expenses, with some puts and takes, were relatively flat from second quarter ’06 to ‘07. SG&A Expenses were up a bit for the periods shown, mainly due to non-recurring events.

On a GAAP basis, as reported, Nanophase lost $0.01/share in Q2 of 2007 versus $0.06/share in Q2 of ’06.

Analyzing the non-cash components of our second quarter ‘07 loss, we have depreciation and amortization of about $356K. This Depreciation and amortization, a regular component of our GAAP bottom line, amounted to almost $0.02/share of the Q207 loss. Equity compensation, also a non-cash expense, amounted to $109K and contributed almost $0.01 per share to the loss. In total, depreciation and equity compensation expense amounted to about two & ½ cents per share. Excluding these items from our GAAP net loss, we had a positive $0.01/share in non-GAAP earnings for Q2 of 2007.

Moving to the balance sheet highlights;

Nanophase ended Q2 with $6.6 million in cash and investments. We also closed an equity investment, for which you may have seen our S-3 filing, that resulted in net proceeds of $10.6 million. This put’s today’s cash and invested balance at more than $17 million.

This financing merits further discussion as the circumstances around it were, in management’s view, quite favorable. We were able to secure a marquee investor, without spending time away from the business, at a 4% discount to a market average, with a smaller than typical commission and no warrant coverage. Based upon our experience, and feedback from other investment bankers we have worked with, the terms of this financing were excellent. We intend to use this money largely to fund expansion of our plant and equipment to accommodate growth over the next several years. Our outlook for 2008 and 2009 is positive, and, depending of course on difficult-to-predict customer demand, we expect to begin utilizing this capital late next year. However, we do not expect to need this additional $10.6 million to fund the day-to-day operations of the business.

EBITDA-O positive is a rough approximation of positive cash flow from operations before funding working capital needs. Without the increase in working capital required to support our revenue ramp, we would have been about $200K cash flow positive for the three months of Q2, on a stand-alone basis. We can see the light at the end of the tunnel.

Q2 inventories are up to $1.4M, about 50% higher than at 12/31, about the same as they were a quarter ago. This increase largely relates to material for which we have orders and solid forecasts. In this case, we continue to make the choice to negatively impact working capital in order to allow for manufacturing flexibility.

This all ties back to what I’ve said about product mix predictability in the margin discussion, along with the revenue ramp.

Equipment and leasehold improvements amounted to about $430K for the quarter. As 2007, and our view toward 2008 and beyond unfolds, as we discussed, we will need to add capital equipment and, potentially, floor space to support future demand. Much of this is product mix dependent and, therefore, difficult to schedule. We still classify this as a great problem to have.

On the liabilities side, the Company now has $1.8million in total debt. All but $105K of this, representing capital leases on lab equipment, relates to the BYK Chemie loan of $1.6M plus deferred revenue less related discounts. Again, given that the loan financing terms are very favorable to Nanophase, including interest-free periods and a low interest rate, we were required under GAAP to adopt this special treatment.

Accounts payable have grown also, directly in relation to the same issues.

We would invite you to review our upcoming 10-Q which we expect to be filed by August 9th.

Thanks for your attention, now I'd like to turn things over to our President and CEO, Joseph Cross.

Joseph Cross, President and CEO

Thank you, Jess.

During the second quarter, and for the entire first half, revenue growth has been primarily driven by two market areas: industrial coatings through our market partner BYK Chemie; and architectural coatings through both direct customers and our market partner BYK Chemie.

Through the first half of ’07, industrial coating revenues increased almost 12 times comparable ’06 sales, growing over 1000% year-over-year. BYK Chemie is aggressively marketing the branded “NanoBYK” products globally, but notably in the US, Europe, India, and Asia. We continue to expect long-term growth in the use of nanoparticles for industrial coatings, a market estimated around $60B globally.

In Architectural coatings, there are now four products incorporating our nanomaterials on two different continents. In the US, there is an interior kitchen/bathroom paint, an exterior stain product, and, recently released, a hardwood floor coating – all of which are marketed to the consumer by DIY retailers. In Europe during this quarter, a major architectural products company also launched an interior paint product. Architectural coating revenues increased over 300% comparing ’07 to ’06 and now comprise our second largest product revenue category.

Equally as interesting, is the value proposition architectural product companies are advertising – improved coverage, antimicrobial/antifungal protection, increased or improved wear, and longer life. It is a value proposition that we hope will spur additional and continuing adoption in the $40B global architectural coating market.

During the last conference call at the end of the first quarter, I discussed Nanophase’s business model and the importance and management focus on gross margin growth. Financial results from both quarters of 2007 and the cumulative first half demonstrate that our business model is working. Through a combination of continuously working to reduce manufacturing cost, systematically increasing pricing where possible, and increased sales and the resultant volume, the Company has experienced sound margin growth, measured both as a percentage of sales and as total dollars.

Viewed over time, in 2004 gross margin averaged 1.4% of sales growing almost 10 times to 14% of sales during 2005. During 2006, we were able to grow margins to 22% of revenue, a 50% improvement year-over-year. During this past quarter, we were able to grow gross margins to almost 37% of revenue and, because of increased volume and sales, gross margin dollars increased 178% year-over-year. For the first half of 2007, Nanophase is averaging cumulative gross margin of 32% of revenue and gross margin dollars have increased 153% compared to the same period of 2006.

I am taking the time to cover this simply to demonstrate the point that the Company focus areas that we discuss on almost each conference call are real to the management team. We are taking several actions to achieve goals in these areas and believe that we are making significant progress.

From an operational perspective, Nanophase continues to perform and improve. During the first half, the operations team achieved 98.1% customer service levels and zero customer returns while scaling-up and delivering six new nanomaterial dispersion products. By the end of the second quarter, the Company also achieved 780,000 hours continuously worked without a lost time accident, which is an extraordinary statistic for a relatively small manufacturing company. During the first half, based on independent expert audits, Nanophase was also recertified to ISO 9001, the International Quality Management System standard, and ISO 14001, the International Environmental Management System. Operational, environmental, and safety excellence are a core competency of Nanophase and are recognized as such by our market partners and customers.

This concludes our prepared remarks, we are available for questions.